Bernanke Hesitates to Extol Economy to Keep Reputation

By Caroline Salas Gage and Rich Miller -
Mar 26, 2012

Federal Reserve Chairman Ben S. Bernanke may be hesitating to extol the improving economy -- in
part to preserve the central bank’s own reputation.

While Fed policy makers upgraded their assessment of the
outlook at their March 13 meeting after the most-robust six-
month period of job growth since 2006, they reiterated their
plan to keep interest rates near zero until at least late 2014,
citing still “elevated” unemployment and “significant
downside risks.” Bernanke said today that continued
accommodative policy will be needed to make further progress.

Bernanke’s caution is “appropriate,” said Peter Hooper,
chief economist at Deutsche Bank Securities Inc. The Fed
chairman risks damaging his credibility by being too optimistic
so soon after adopting the 2014 pledge in January and before
having conviction about the economy’s momentum, Hooper said.
Policy makers fueled speculation in 2011 that monetary
tightening was coming by laying out their exit strategy, and
they don’t want to guide the market prematurely again, he added.

“They were not at all discouraging some talk about the
exit” a year ago, Hooper said in an interview from his New York
office. “They’re not going to make that mistake twice. Bernanke
is going to be very patient.”

Yields on benchmark 10-year Treasury notes were 2.26
percent (USGG10YR) at 10:28 a.m. in New York, up from 1.8 percent Jan. 31,
according to Bloomberg Bond Trader prices, as manufacturing data
improved and jobless claims dropped. The yield had climbed to
3.74 percent in February 2011 as policy makers outlined how they
planned to withdraw their record stimulus.

Unprecedented Steps

Even though the recent increase reflects signs of strength
in the economy, Fed officials probably won’t welcome the rising
yields after the unprecedented steps they’ve taken to reduce
rates, according to Ward McCarthy, chief financial economist at
Jefferies & Co. in New York.

In addition to pushing out expectations for higher
borrowing costs, U.S. central bankers have kept their benchmark
rate between zero and 0.25 percent since December 2008 and
bought $2.3 trillion of bonds in two rounds of asset purchases.
They’re also pursuing a maturity-extension program announced in
September to replace $400 billion of short-term debt in the
Fed’s portfolio with longer-term securities. The so-called
Operation Twist is scheduled to be completed in June.

‘Stronger Economy’

Rising bond yields are “a reflection of a stronger
economy,” James Bullard, president of the Federal Reserve Bank
of St. Louis, said in a Bloomberg Television interview last
week. “Low yields might sound good, but” they can “represent
a lot of pessimism.”

Bullard, who doesn’t vote on the policy-setting Federal
Open Market Committee this year, said U.S. monetary policy “may
be at a turning point,” and the Fed’s first interest-rate
increase since the global financial crisis may come as soon as
late 2013.

Federal Reserve Bank of New York President William C. Dudley offered a more cautious view on March 19, saying signs
the economy is improving don’t dispel risks to growth that
include higher gasoline prices, fiscal cutbacks and a weak
housing market.

The data have been “a bit more upbeat of late,” Dudley
said in Melville, New York. “But while these developments are
certainly encouraging, it is far too soon to conclude that we
are out of the woods in terms of generating a strong,
sustainable recovery.”

Declining Labor Participation

About half the drop in unemployment since September “was
due to a declining labor-force participation rate,” said
Dudley, who is also vice chairman of the FOMC. Had participation
not decreased “from around 66 percent in mid-2008 to under 64
percent in February, the unemployment rate would still be over
10 percent.”

Joblessness has fallen to 8.3 percent, the lowest in three
years, from 9.4 percent at the end of 2010 and a high of 10
percent in October 2009.

“A wide range of indicators suggests that the job market
has been improving, which is a welcome development indeed,”
Bernanke said today to the National Association for Business
Economics in Arlington, Virginia. “Still, conditions remain far
from normal, as shown, for example, by the high level of long-
term unemployment and the fact that jobs and hours worked remain
well below pre-crisis peaks, even without adjusting for growth
in the labor force.”

Communications as Easing Tool

By being more optimistic, Fed policy makers would encourage
traders to move up their expectations for monetary tightening.
That may weaken the effectiveness of using policy forecasts,
like the 2014 plan, as stimulus. Bernanke has said that
communications are among the main easing tools left after
reducing the federal funds rate.

Bernanke’s view is “‘we’ve gone pretty far here with our
verbal policy messages; we’re not about to upset this just
because we have a little bit of good data,” Hooper said. “It’s
going to take quite a few months of very good news, with the
market moving well ahead of them,” before Bernanke will signal
the exit is approaching.

Money-market-derivatives traders predict the Fed will lift
its target rate for overnight loans between banks a year earlier
than the late 2014 forecast. Forward markets for overnight index
swaps, whose rates show what traders expect the federal-funds
effective rate will average over the life of the contract,
signal a quarter-percentage point advance around the October-
November 2013 period, according to data compiled by Bloomberg as
of March 23.

‘Very Limited’

“Our ability to say with any precision what the date of
liftoff will be is very limited,” Bullard said in the Bloomberg
television interview. “Markets have to understand that. Policy
makers have to understand that as well.”

Dudley stopped short of calling for additional stimulus
from the Fed last week, saying “nothing has been decided”
about more bond-buying.

“The market focuses on direction and growth rates” of the
economy, while “the Fed focuses on levels,” such as
unemployment, said Lou Crandall, chief economist at Wrightson
ICAP LLC in Jersey City, New Jersey. “Year in and year out,
that’s one of the most fundamental sources of miscommunication.
The Fed cares about the gap.”

Continuing Housing Weakness

Dudley’s focus on weakness in the housing market was
supported by data last week showing purchases of new homes
unexpectedly fell in February for a second month. Sales dropped
1.6 percent to a 313,000 annual pace, the slowest since October,
from a 318,000 rate in January that was weaker than previously
reported, according to figures from the Commerce Department. The
median estimate of 78 economists surveyed by Bloomberg News
called for a 325,000 pace.

Bernanke shared Dudley’s concerns about the impact on
consumers from higher energy prices when he spoke before the
House Committee on Oversight and Government Reform March 21.
Gasoline jumped to a 10-month high last week, with the price for
April delivery at $3.3852 a gallon on the New York Mercantile
Exchange March 23. Futures have climbed 26 percent this year.

“Higher energy prices would probably slow growth, at least
in the short run,” Bernanke said. Rising fuel costs create
“short-term inflation pressures, and moreover, they act as a
tax on household purchasing power and reduce consumption
spending, and that also is a drag on the economy.”

Above Average

The Fed’s forecasts for growth still are above the average
Wall Street prediction. Central bankers predicted in January
that the U.S. economy would expand by 2.2 percent to 2.7 percent
in 2012, compared with a median projection of 2.2 percent in a
Bloomberg News survey of 70 economists from March 9 to March 13.
The Fed will update its economic forecasts at its April meeting.
The U.S. expanded 1.7 percent in 2011.

Expectations for additional stimulus have declined since
the FOMC’s March meeting, when policy makers acknowledged the
economy is improving. Forty-seven percent of investors in a Bank
of America Corp. survey released March 20 predict no further
asset purchases by the Fed, up from 36 percent in February.

While the odds of a third round of bond buying, or so-
called quantitative easing, are declining, the Fed’s “pretty
dim view of the economy” has kept the option alive, said
Stephen Stanley, chief economist at Pierpont Securities LLC in
Stamford, Connecticut.

“I don’t think they’ll do QE3, but I would readily
acknowledge that it’s not entirely off the table,” said
Stanley, who predicts the Fed will raise interest rates in
mid-2013. “They view the risk of careening into deflation as so
much more severe than overstaying their welcome, so they’re
prepared to err in that direction.”